Thanks to everyone who responded to this week's Mystery Chart. Responses were somewhat mixed. It was a daily chart of the iShares Medical Devices ETF $IHI.
What we really wanted to know is whether or not investors are buying these kinds of bullish continuation patterns right now. Many alluded to the underlying trend being higher but still wanted to wait for the flag pattern to resolve before taking action.
This is a prudent approach and we're looking at the chart in a similar light. With that said, we're also viewing setups like this within the context of what is going on in other areas of the market. In other words, as more and more of these patterns resolve to the upside, which they are, the higher the likelihood is that others will follow their course.
In this post, we'll walk through our top-down approach to highlight why we like Medical Devices right now and then drill into some of our favorite setups as a way to express our bullish thesis.
Here is the chart. I've added a Fibonacci extension from the Q1 drawdown.
Click on chart to enlarge view.
While we're definitely leaning in the direction of the primary trend, which is higher, we want price to prove itself and break out of the tight range its been coiling in for the past month before getting involved. We only want to own Medical Devices at the index level on strength above its recent highs of 297 with a target at 337.
On the other hand, if we're below 288 we don't want anything to do with this in the near-term as we could see a quick 5-10% move lower towards former support and resistance in the 250-270 range. In this case, we'd prefer to be on the sidelines but would eventually be looking to buy strength back above the former highs near 278.
We can discuss that if/when the time comes, but for now the risk/reward isn't nearly as favorable in the ETF itself as it is in some of the funds' strongest holdings. We'll get into those below, but first, let's reverse engineer how we came to like Medical Devices using our top-down approach.
You already know we're bullish on US Equities and have been for a while. We're also very bullish on Health Care $XLV as it's been a sector leader for a long time now.
Similar to Medical Devices, XLV is also currently consolidating at record levels, just above its prior all-time highs from Q1. You can read more about our current outlook on the sector in JC's post from earlier this week.
So to recap, we're bullish stocks and Health Care is one of our favorite sectors. The next step is to identify the industry leader(s) within Health Care... and guess what, it's been Medical Devices for several years now. Check out the impressive performance of Medical Devices relative to the Large-Cap Health Care SPDR $XLV.
Since breaking out of a multi-year base against Health Care in 2016, Medical Devices have been steadily outperforming and stair-stepping higher relative to their sector for the past four years. The ratio is currently sitting at all-time highs.
Medical Devices haven't just been outperforming Health Care in recent years. They've actually been one of the secular leaders in the entire US stock market for a long time.
If you want more evidence, just look at this long-term chart of Medical Devices with its relative strength vs the S&P 500 in the lower pane.
The primary trend is unequivocally higher on an absolute basis as well as relative to the S&P 500. We love betting on strong structural trends like these, especially when we have a fresh breakout and well-defined risk levels.
With that as our backdrop, let's look at some long setups in a handful of IHI's strongest components.
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